Originally published in the News Star on Sunday, June 5, 2016.
Question: With stocks overvalued and bonds looking riskier than ever, if interest rates go up it’s really hard to know where to put your money. Are there asset classes that are being overlooked?
Answer: Yes. A very big one.
For purposes of this discussion, let’s define cash as broadly as possible. Cash is the currency in your wallet (or that safe in your house you thought nobody knew about), the funds in your bank checking and savings accounts and even money market accounts. It is the medium of exchange with which we can buy things.
Cash is the offensive lineman of personal finance – its huge, it’s important, it’s not sexy and nobody ever thinks about it – until you need it. And by the time you realize you need it or you don’t have enough, it’s often too late.
It’s nearly impossible to separate the idea of cash from cash flow – as the phrase suggests, that’s the flow of cash into and out of a financial system.
For a business, as well as an individual, cash flow is like oxygen flow to the body. There may be plenty of oxygen out there somewhere, but if it’s not flowing into and out of my body right when I need it, I have a very slim margin of error available to me. Just as the body quickly dies when deprived of oxygen, individuals and businesses die (i.e., go bankrupt) when experiencing a shortage of cash.
Anytime I work with a successful small business person, I find an almost reverential appreciation for cash – having lots of cash, “too much” cash and access to even more through lines of credit if needed.
So that we don’t experience such a deadly deprivation of cash, it’s necessary to have a plan for cash. Here are five arenas in which such cash flow planning is critical:
Lifestyle cash flow. Nothing else happens until you tame this beast. You have a certain amount of money coming in the front door. For most of us that means earned income from a job. Priority number one is to spend less than that – ideally, about 15% less. That way you can save for the rest of these priorities.
Emergency / opportunity cash flow. We never know when an emergency may arise or an opportunity may present itself. To be ready, have at least six months of your income readily available in cash. If you currently have zero, take heart – if you can spend 15% less than you take in (thereby saving 15%), you’ll reach this goal in 3 to 4 years.
Catastrophe cash flow. Some things require cash in amounts that are essentially impossible to save. If your house burns down, you can’t just go to the old piggy bank and take out a loan. So be certain that the half dozen or so areas of major risk exposure (i.e., catastrophe) are covered adequately with insurance (which delivers cash at just the time you need it to pay for said catastrophe).
Investment cash flow. Ultimately, any investment you make must be turned into cash for it to be of any value to you. Do you know how you’ll convert land, houses, buildings, stocks, bonds, or baseball trading cards to cash, one day? Many investments actually pay you a certain amount of cash – bonds pay interest, stocks may pay a dividend, houses and buildings may pay rent and land may be leased either to farm or use recreationally.
Retirement cash flow. Finally, when you exit the work force (either voluntarily or not), how will you replace the flow of cash you regularly received from your employer with cash from…what? Most will have Social Security. But what else for you? Do you know how you will convert a 401k, IRA or other retirement plan to cash? And will doing so create another risk – of running out of money?
It pays almost no interest. It doesn’t make for interesting conversation. And the only way to double your money with it is to take it out of your wallet and fold it over.
Despite its boring trappings, cash should not only be a significant part of your financial plan, it should be its center piece.
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